Why do we tolerate income inequality?

Harvard Business Review study has potential impact on ‘fair tax’ debate

By Ted Cox

Income inequality is at a record level in the United States. Economists have suggested for years that at some point income inequality reaches a tipping point in which the greater society won’t stand for it, and revolution ensues, as in the French Revolution.

Yet U.S. citizens stand for it, and the only real signs of revolution are the “political revolution” U.S. Sen. Bernie Sanders is running on as a Democratic presidential candidate. Not to diminish that — it speaks volumes that American voters are increasingly more attracted to Democratic Socialists, as in the Chicago and Rock Island city councils — but it’s not a real mobs-with-pitchforks revolution.

Why do we tolerate income inequality? The Harvard Business Review was out with an explanation this week that might have applications in the debate over the “fair tax” Illinoisans will be voting on in less than a year.

The HBR story noted right away that the issue is closely tied in with the notion of a “meritocracy” — that those who earn more money deserve it precisely because they earned it, in something of a tautology. But what it found to be even more important was how that played out for individuals and their immediate circumstances compared to those around them.

In other words, the very rich might be getting even more rich, and that’s certainly the case in the United States. Just this fall, the U.S. Census Bureau released the latest Gini index, which measures income inequality on a scale of 0 to 1, with 1 translating as a society where all income is earned by one person and 0 being a society where everyone makes the same. The current U.S. Gini index of 0.485 set a record high since the Census Bureau began compiling it nationally in 1967, when it stood at just 0.397. Back in the present day, last year no European country had a Gini index above 0.38

But why do we tolerate that? The Harvard Review story suggested that, when it comes to day-to-day happiness and satisfaction, status relative to our peers is more important than the larger social inequity. In other words, the very rich might be making a lot of money and living their lives in, say, Malibu in Southern California, but when we make just a little bit more money than those around us, increasing our status, that translates more into immediate happiness.

“Each step up the ladder pays out more in terms of happiness,” the story found, and that phenomenon was actually more pronounced in societies with greater income inequality: “The more unequal the society, the more moving up the income ladder contributed to someone’s overall well-being.”

This has potentially profound applications in the Illinois tax debate. With the state’s current flat tax, everyone in theory pays the same 4.95 percent. But taking 5 percent from someone earning $20,000 a year is vastly different from 5 percent for someone earning $1 million. Ralph Martire, executive director of the Center for Tax and Budget Accountability, brought this up just this week in a debate on the graduated income tax. He cited data from the Institute of Tax and Economic Policy finding that the bottom 20 percent of Illinois wage earners pay 14.4 percent of their incomes in state and local taxes, while the top 1 percent pay just 7.4 percent — and the actual rates are even more inequitable than that when you figure in that everyone is paying the same for car license registration and other state and local fees.

“You have to raise revenue from where the economy is growing, not declining.”

Ralph Martire, executive director of the Center for Tax and Budget Accountability (One Illinois/Ted Cox)

But, again, consider, with every increase in income under that regressive tax system, one is taking a step toward what is in effect that lower overall tax rate. Disposable income increases, or the money is suddenly there for necessities like child care or healthy meals.

This is a common argument for anti-taxers, and it plays out in dogma like “It’s your money, you deserve to keep it.” What was interesting about this week’s tax debate is that Dan Proft, the conservative WIND 560-AM radio host who argued against a progressive income tax, never once fell back on that tried-and-true line. Instead, he said high taxes were driving the exodus in Illinois population, and that taxpayers can’t trust Illinois government not to pass on inevitable tax increases to the middle class due to the state’s underfunded pension system.

That last argument is readily refuted. If it’s indeed true that the state is going to have to raise taxes to pay pensions, then the average taxpayer is going to pay a lot less under a progressive tax in which the rich pay more than he or she would under a flat tax in which everyone pays the same basic rate. Gov. Pritzker made the same argument when he first introduced his “fair tax”: that if the state didn’t pass a graduated income tax to raise revenue, then it would have to raise the tax rate on everyone to 5.95 percent. Nobody wants that — nobody but the already comfortable rich, that is.

But each individual voter is also going to have to recognize that there is a larger society out there with a greater social inequity than is usually observed in the workplace with one’s peers. As Martire pointed out, a regressive flat tax doesn’t address income inequality. A progressive tax does. As he put it, the primary goals of any taxation system should be to draw from growth sectors and “assess tax policy fairly among people with very different incomes.” He added, “There is only one tax in the entire tool kit that can respond to this — and that’s the income tax.

“You have to raise revenue from where the economy is growing, not declining,” Martire said. The state’s current flat tax rate is actually “missing where all of the growth in the economy is occurring."

Martire heartily endorsed a progressive income tax, saying, “We need this tool in the kit.” It targets where people and businesses are thriving and thus capable of paying more. So, in the end, one can settle for the incremental shifts of making a little more money than those around you and enjoying the hike in relative status, in what amounts to collecting crumbs, or one can call for real institutional change by calling on those with the ability to pay more to simply pay more because they can — a tautology most everyone can agree on.

But that’s the cutting edge of meritocracy in the Harvard Business Review story. Yes, some people earn more because they’ve, yes, earned it with hard work, but others have been merely lucky. Pay for top business executives has escalated much more than for the average working Joe over the last few decades, even as worker productivity has increased. Steven Greenhouse’s new book, “Beaten Down, Worked Up: The Past, Present, and Future of American Labor,” cites figures showing that, from 1948 through 1973, worker productivity and hourly pay rose on parallel lines, up 95.7 percent and 90.9 percent. But from 1973 through 2016 productivity rose more than six times faster than wages. Over a similar timespan, chief executive officers at the largest 350 U.S. corporations saw their pay rise to 350 times that of the average worker, up from 59 times the average in 1990 and just 20 times the average in 1965. Is that because those top executives are actually doing far more to increase profits than their predecessors in the ‘60s, or is it because the balance of power has shifted in many businesses from workers to shareholders?

But, again, that’s an intellectual argument based on reason and hard data. The Harvard Business Review suggests there’s another level at play that involves the feelings workers have about their status compared to their peers, not their income compared with the very rich.

Are Illinois voters going to have to overcome their “feelings” about where they stand comparable to their neighbors in order to embrace the clear common good of a progressive income tax statewide? We’ll see as the debate rages over the next year.